Yesterday I wrote a short post on my thoughts on the FED cutting by 50 basis points and what I thought would be the effect on mortgage rates and possibly the economy going forward.  I said that I thought the cut was a very dangerous move despite the obvious hardships facing our economy and banking system.  This is because the US dollar is in a very precarious position and we have substantial inflation pressures on the horizon ($83/barrel oil).

We'll it appears one of the side effects I was worried about is in fact taking place and fairly rapidly.  The 10 year treasury rate is now up another 15 basis points today.  So we've got a circumstance where the the fund lowered the federal fund rate but the 10 year treasury rate is increasing very rapidly.  The 10 year treasury rate is not set by the FED but rather by the market and is much more important to the overall economy and mortgage rates.

So why is the 10 year rising after the FED lowered?

The main reason for this is foreign capital flight out of the US dollar.  The cut has left many foreigners worried about the FED's ability to contain inflation, which has lead to them beginning to pull investments out of US dollar denominated assets.  A huge portion of US treasuries are held by foreigners so as they've reduced their investment it's created less demand.  Supply vs. demand dictates that if the supply is staying essentially the same and demand is weakening that the price is going to come down, pushing up the yield/rate.

So in effect the rate cut by the FED is actually having the opposite effect that many hoped it would.  It's actually causing long term interest rates which are much more important to the economy and particularly the real estate/mortgage industry to rise.

5 day chart of the US Dollar

5 day chart of the 10 year treasury

Update

Inman News put up a good post about this earlier today that can be found here.